How Do Companies Make Money from an IPO?

An IPO represents a major financing opportunity for any company. The main purpose of an IPO consists of raising funds through the sale of equity in the company and getting their stock listed on a stock exchange.

When an IPO takes place, many people stand to make a lot of money, including the founder(s), the stock’s underwriters and the original investors who have agreed to sell an interest in their share of the company.

To understand how a company makes money from an IPO, a general idea of how an IPO is structured can help.

An IPO begins with the decision by the company to divest a part of the firm through the sale of common stock.

The company — which is privately held — then hires an investment banker. An investment banker consists of a type of merchant bank which underwrites shares, meaning they are the first to sell stock to the public.

The Underwriting Process

Once an underwriter has been hired, a long process begins to determine the price of the initial offer. The preliminary procedures include a thorough analysis of the company by the investment banker and a complete assessment of the current value of the company, including its assets and liabilities.

The investment banker also prepares projections on the company’s future profitability and reports how the company is expected to perform after the IPO. Once the investment banker has completed these steps, the process is ready to move on to the next phase.

The underwriter, having made a thorough assessment of the company can begin writing up a prospectus or informative bulletin announcing the IPO, and registering the IPO and filing the appropriate paperwork with the SEC. The prospectus includes the financial details of the company and the amount of shares to be issued.

At this stage of the process, the price of the newly issued shares will not have been disclosed nor the date the IPO is scheduled to occur. This keeps the market’s interest up as to what the price may be, and what day the IPO will take place.

Furthermore, the prospectus is distributed only to the clients of the investment banker, who in many cases need to be on a list to receive it. Some companies promote their IPOs with their investment banker putting on a road show, to showcase the company and promote the sale of the shares to fund managers and financial institutions.

The Initial Public Offering

Once the company has been promoted extensively, a date for the IPO is revealed. The price however continues to be kept under wraps. As the day approaches, speculation over the price grows with the market’s expectations rising.

The price is set close to the day of the IPO, giving the company a valuation on the stock market and making the company’s value generally increase considerably in the process. This is where the company makes money on an IPO.

Not only does the company instantly receive a large infusion of cash, but the original investors and employees with an interest in the company also become instantly wealthy upon the valuation of their stock in the market.

The upcoming Facebook IPO is believed will produce one thousand instant millionaires, in addition to some billionaires. Other well-known IPOs which have produced instant billionaires and millionaires include Google, Apple and Microsoft.